Earnings Management Strategies During Financial Distress

The IUP Journal of Accounting Research & Audit Practices, Vol. XVII, No. 3, July 2018, pp. 52-78

Pace University Accounting Research Paper No. 2018/05

Posted: 28 Nov 2018

See all articles by Neerav Nagar

Neerav Nagar

Indian Institute of Management Ahmedabad

Kaustav Sen

Pace University - Lubin School of Business

Date Written: July 19, 2018

Abstract

The paper examines whether financial distress and its severity have a role to play in managers’ decisions with respect to the choice of earnings management strategies. The results suggest that firms in initial stages of distress engage in real earnings management through a reduction in the spending on selling and general and administrative expenses, and through classification shifting to increase profitability and liquidity. When distress becomes severe, firms cut back on production, engage in income-increasing accruals management, and increase their spending on selling and general and administrative expenses. Initial under-spending on selling and general and administrative expenses is opportunistic with an intention to show improved performance. In extreme distress, increase in such spending is a sound economic decision. The findings provide insights into how managers of distressed firms trade off between liquidity, profitability and solvency both in the short run and the long run.

Suggested Citation

Nagar, Neerav and Sen, Kaustav, Earnings Management Strategies During Financial Distress (July 19, 2018). The IUP Journal of Accounting Research & Audit Practices, Vol. XVII, No. 3, July 2018, pp. 52-78; Pace University Accounting Research Paper No. 2018/05. Available at SSRN: https://ssrn.com/abstract=3286840

Neerav Nagar (Contact Author)

Indian Institute of Management Ahmedabad ( email )

Vastrapur
Ahmedabad, Gujarat 380015
India

Kaustav Sen

Pace University - Lubin School of Business ( email )

1 Pace Plaza
New York, NY 10038-1502
United States
212 618 6413 (Phone)
212 618 6410 (Fax)

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